Day of the Mifid

Shedding light on some of the legislative changes being brought
in on 3 January

December 19, 10:02 PMKickerThis is a kicker.

Mifid II \- the Markets in Financial Instruments Directive II \- is coming into force on 3 January.
While there are some parts that are directive and some that are legislative, all countries covered by the European Union's Mifid II changes must be ready next year to show they are treating customers fairly, honestly, openly and transparently.
Yet there are many hitherto hidden or unintended consequences of the new directive which will affect financial advisers and their clients, which had not been properly understood even a year ago.
This report, together with the CPD content within, aims to provide advisers with an overview of some of the biggest changes that might affect the way in which they work with providers, platforms and clients after 3 January 2018.

Mifid II: A help, not a hindrance

The majority of advisers think Mifid II will help improve standards in the industry.
A poll carried out by _FTAdviser_ among readers this month showed 72 per cent of those who took part believed it would be a help and only 28 per cent of those who voted said it would be a hindrance.
A breakdown showed 39 per cent think it will help improve industry standards, while another 33 per cent said it would be good for clients.
Mifid II comes into force on 3 January 2018.
Linda Gibson, director of regulatory change and compliance risk at BNY Mellons Pershing, said: "Mifid II heralds change and change brings opportunity.

> Asset managers will need to ensure that their products function as intended to avoid any potentially detrimental consequences for investors

"Firms have a significant opportunity to overhaul their operations and improve efficiency, risk management and client outcomes.
"Compliance initiatives should be streamlined and sustainable, but leave room for innovation.
Jackie Beard, director of manager research services for Morningstar in EMEA, suggested the new regulation would push asset management firms to check their funds are fit for purpose and that they offer value.
She said: "Asset managers will need to ensure that their products function as intended to avoid any potentially detrimental consequences for investors.
"As well as a regular review, they will be obliged to review their products when they become aware of an event that could materially affect the potential risk to investors.
"We think the industry developments brought about by Mifid II will be good for investors.
"High fund fees and value for money will be brought to the forefront of attention, and asset managers will no longer be able to ignore the continued existence of funds that have lost their way."
But the poll also revealed 17 per cent think the new standards are a hindrance because they are unnecessary, while 11 per cent believed the high costs made it a hindrance.

Scott Gallacher, chartered financial planner at Rowley Turton, said generally regulation is a good thing.
But he added: "There is an argument that perhaps there is too much regulation and a danger that the regulators and government seek to over\-regulate the industry on the grounds that it is viewed as a free lunch.
"It is not a free lunch.
"It takes time from advisers when they could arguably be advising clients. Given there is a shortage of advisers, that is counter productive."
Some regulation made financial advice less efficient, according to Mr Gallacher, in the sense if there is over\-regulation it would increase the costs to advisers.
[Industry polls have found some asset managers](https://www.ftadviser.com/investments/2017/09/05/managers\-not\-yet\-ready\-for\-mifid\-ii/) and advisers firms admitted they were not prepared for the implementation of Mifid II.
In November, [platform provider Nucleus published a guide to Mifid II](https://www.ftadviser.com/regulation/2017/11/08/better\-business\-nucleus\-launches\-mifid\-ii\-guide\-for\-advisers/) for adviser firms after it surveyed advisers and found less than half were confident or very confident they would be ready for the regulation when it came in next year.
_Ellie Duncan is deputy content plus editor for FTAdviser_

Regulation has been one of the most pressing issues for the UK's financial advisers during 2017 and looks set to continue this way in 2018.
But increasing regulation, both in the UK and in Europe, is not the only trend that might continue into 2018.
As James Rainbow, co\-head of UK intermediary for Schroders commented, the trend to outsource, and concerns over how Brexit might pan out, also loom large in advisers' minds.
These were some of the findings of research carried out over 2017 by Schroders among financial advisers.
Moreover, he told FTAdviser there could be more consolidation and mergers within the fund management industry over the course of 2018.

Mifid II: What you need to know

Mifid II the second phase of the European Unions Markets in Financial Instruments Directive is just a few weeks away.
It is one of the widest\-ranging pieces of investment legislation for many years, touching on nearly all aspects of trading, whether as individuals, corporate entities, charities, trusts or discretionary managers.
The directive fits within all the other various pieces of legislation, springing out of the mire created by the 2008 financial crisis, and is causing some compliance departments quite a few headaches.
A survey commissioned by Intelliflo and published in December 2017 found that Mifid was a big issue for advisers.
When asked what the biggest challenges for their businesses were over the next 12 months, respondents to the survey listed:
1. Complying with Mifid II.
2. Being ready for GDPR by May 2018.
3. Cyber security.
4. Recruiting staff.
5. Robo advice.
6. Preparing for Brexit.
Rob Walton, chief operating officer at Intelliflo comments: Although Mifid II comes into effect at the start of the year, our survey reveals the concerns advisers have about being fully compliant with it.
Yet the legislation is supposedly bringing in positive change for investors. As the Financial Conduct Authority \(FCA\), the body responsible for implementing Mifid II in the UK, has claimed, it will strengthen investor protection.
In the words of the FCA, says Richard Romer\-Lee, managing director of Square Mile Investment Consulting and Research, Mifid II aims to strengthen investor protection, reduce the risk of disorderly markets, reduce systemic risks and increase the efficiency of financial markets, and reduce unnecessary costs.
While the industry broadly welcomes anything that makes investing better, there are many more obligations and duties upon advisers, fund managers, discretionary fund managers, platforms, product providers, research analysts and the end investors themselves, which need to be grasped before 3 January 2018.
**Suitability**
One of the main points for advisers is in the way suitability reports must be carried out.
Although essentially Mifid II does not fundamentally change the requirements already on UK advisers, namely to ensure the fund they recommend will be suitable for each individual, it does impose a new obligation on investment advisers to provide suitability reports to retail clients before any transaction is concluded.

> What Mifid II does is bring a whole new level of mandatory transparency

This is the view of Susann Altkemper, counsel for City law firm CMS, who comments: In practice, this might be difficult to achieve, and unless advisers can rely on a narrowly drafted exception, they will need to adjust their processes or consider changes to business models altogether.
She points out that suitability reports are also required where the advice does not lead to a transaction, or where the advice is not to buy or sell a financial instrument, and whether there had been better alternatives.
The implication is that where there is no trade or transaction, advisers may have not kept detailed documentation on such advice beforehand.
This all changes under Mifid II advisers will have to make sure they keep extensive and detailed file notes.
Moreover, advisers cannot just state to the regulator that they met the definitions of suitability, they have to state how suitability is met, Jennine Watts, regulatory solutions manager at SEI Wealth Platform, advises.
This means advisers will really have to know their target market, and ascertain whether a particular fund is suitable for a particular client.
**Target market**
A fund manager under Mifid II must state what the target market is for a fund the firm creates.
For these firms, this means a far greater focus on product, target market, cost and appropriateness. It also means providers need to give more information to advisers to make their recommendations in the first place.
In practical terms, under Mifid II, providers must define the target market for each one of their assets, and should have done so well before 3 January 2018.
They will need to be crystal\-clear about what their funds are supposed to do, and at whom the funds are targeted. Advisers will need to make sure the product and the target market are in line.
According to Richard Janes, spokesman for Brewin Dolphin: There are requirements on manufacturers to identify the risks of their investments, and define the appropriate target market.
There is an onus on distributors who will need to consider the target market alongside their overarching suitability obligations.
Under Mifid II, manufacturers of products will have to pay attention to the investor at every point in the process from design to distribution.
With the proliferation of funds across Europe, it becomes imperative under Mifid II for product providers to be open and transparent about the funds they create, and for whom.
If, for some reason, a financial adviser chooses to use a fund for a client, who is not considered part of the target market, the adviser must be clear in reporting back upstream to the provider.
Fund managers and advisers with discretionary permissions fall within Mifid IIs catchment area; even if advisers do not produce and run their own funds, it is best practice to check a third\-party managers funds are meeting the requirements.
**Call recording and reporting**
Alex Mawson, product director of voice networks at Daisy Group, warns that all firms, large and small, will need to pay attention to whether their current call recording processes go far enough.
What Mifid II does is bring a whole new level of mandatory transparency, expanding the remit to mobile calls and text messages, on both company\-provided and personal devices.
And with the stakes being so high, this is not something businesses can assume is already within their capabilities.
According to Ian Hook, vice\-president of European business operations at Smarsh, some IFAs may be unaware of the onus Mifid II will put on their communications.
This could include Facebook Messenger or LinkedIn conversations where recommendations might be perceived to have been given all of this will need to be recorded and stored somewhere.
He warns: If you are going to capture your digital communications, whether because your business falls under the regulations, or you have decided to voluntarily comply, then make sure you know what comes under the umbrella of communication.
**Costs and charges disclosure**
From 3 January onwards, asset managers will be forced to break down costs clearly and simply into four key categories for each fund.
In a nutshell, these are:
1. The ongoing charge.
2. One\-off fees such as entry and exit charges.
3. Incidental fees, such as performance charges.
4. Transaction fees relating to the investment product.
Mifid II is clear about what cost information must be made clear to investors.
As outlined by Ms Altkemper, this is: All costs on an aggregated basis, relating to both the service or ancillary service provided, plus the costs incurred in relation to the investment recommended or marketed.
Disclosures must also cover any third\-party costs.
Under Mifid II, all costs must be expressed in two ways: as a percentage, and as a cash amount.
Moreover, all retail clients will be given an illustration showing the cumulative effect of costs on returns, and any anticipated spikes or fluctuations.
To add to all this documentary information to clients, any previous disclosure requirements on cost and charges will be enhanced with the obligation for firms to provide the client with a comprehensive illustration of all expected point\-of\-sale \(ex\-ante\) costs and charges, including their overall effect on investor returns.
The purpose of this is to ensure the client gets a specific and tailored breakdown of all the costs and charges they have paid out.
Says Ms Altkemper: While clients will benefit from an increase in transparency, firms will need to develop compliant costs and charges disclosures.
This will involve advisers having to collate data internally, and even from external sources, such as other firms in the distribution chain.
Jackie Beard, director of manager research services for Morningstar, is an advocate for this change: The increase in fee transparency, brought about by Mifid II, is welcome, in our view.
**Adviser platforms**
Under Mifid II, the onus on platforms will increase, in terms of the burdens of disclosure of risk, remuneration and assets, as well as carrying out enhanced reporting.
Firstly, costs and charges will mean platform fees come under the spotlight. Heather Hopkins, head of Platforum, explains: Clients will have a clearer view than ever before of all costs and charges, including the investments.
Then there are the pre\-sale valuations, which have to show estimated costs for the fund, and now the cost of the platform, advice and even the cost of investment research.
There will be a need for a post\-sale illustration with actual and anticipated costs provided.
Investors will also need to receive valuations at least quarterly, and an annual statement of costs, while providers using platforms must still ensure the products are reaching the right customers.
All this means more information and more data\-sharing between adviser, DFM, platform and provider.
**The 10 per cent rule**
Under Mifid II, there is a requirement for those running a discretionary managed portfolio to notify clients quarterly every time there is a 10 per cent drop in the value of that portfolio.

> Firms will need to develop compliant costs and charges disclosures

This should be done within 24 hours of the drop occurring and it is the DFMs responsibility to inform the client.
Therefore, any wealth manager discretionary permissions will need to ensure they have a mechanism in place to track portfolio performance and notify clients of a 10 per cent drop.
It also means advisers will have to provide up\-to\-date contact details to allow the DFM to contact the client. This means a third party will have access to an advisers clients not a situation with which many advisers will be comfortable.
However, the notification only needs to be given for a discretionary managed part of a total portfolio. Should the overall portfolio drop 10 per cent, there is no need for a notification.
In a blog post for platform Nucleus, Phil Young, founder of support service Zero, commented the 10 per cent rule was nuts.
According to a spokesman for Novia, most financial advisers will not be affected unless they have discretionary permissions and very few do.
That said, as with any regulatory change, it is worth checking permissions are up to date.
**LEI and the Nino**
There is also the need for some advisers with discretionary permissions to have a legal entity identifier \(LEI\) in place.
Under Mifid II, a new set of standards for investing in exchange\-traded assets or exchange\-traded instruments \(ETAs or ETIs\) are being put in place under new transaction reporting rules.
Providers under Mifid II will need to know who is the beneficial owner of an ETI, and who is the decision\-maker in respect of the transaction.
This means where advisers are dealing with legal entities, such as trusts, charities or corporates, they will need to have an LEI in place so they can continue trading in ETIs.
Any advisers who do not already have an LEI can get one from the Stock Exchange for an upfront 115 initial charge and an annual 70, not including VAT.
Individual clients will need to provide their advisers with their National Identifier \(Nino\), to provide to platforms or providers. Without this information, platforms and providers will not allow any trades in ETFs after 3 January.
For the majority of advised clients in the UK, this will be the National Insurance number. Unless, of course, a client has dual citizenship.
Under the current EU rules, which seem rather bizarre, there appears to be an alphabetical quirk. So, say a client living in Hampshire, UK, has dual nationality Austrian \(A\) and British \(GB\).
It is perfectly reasonable the IFA might only know about their clients UK citizenship, so may assume this clients Nino will be their UK National Insurance number. But no.

> If the firm pays for research centrally, it could end up in an overall reduction in cost for the client

Austria is before GB in the list of EU countries drawn up alphabetically under Mifid II, so until the UK comes out of Europe, the National Identifier number the adviser must give to the London Stock Exchange for that client to be able to trade exchange\-traded funds after 3 January, will have to be the Austrian one, not the UK one.
But when we come out of Europe, it is understood that this alphabetical order will not apply if someone has joint British and citizenship of another European country.
However, someone living and working and paying tax in the UK, who happens to be joint French and Italian citizen, might pose more problems for the IFA, as the Nino will need to be the French one.
This seems very arbitrary, according to one platform, and it is something that is apparently still needing to be ironed out before the rules come in.
Until there is more clarity, the platform suggests it is always best to check who holds dual citizenship, and work out which information will be needed to provide a national identifier for corporate and individual clients wishing to trade ETFs after 3 January.
**Research costs**
Research costs is another area being brought to the fore by Mifid II.
The measures under Mifid II are basically to unbundle the costs of research bought by the fund manager, so investment firms can show they are not being induced to trade.
They will, from 3 January, have to put in place systems that can manage unbundled payments for execution and advisory services, and be able to show the research and pricing models for those services.
Some fund managers are going to absorb the costs, a few will pass it onto their clients, and others just will not be affected, as they have always done their own research within their management teams and not relied on external analysts.
The main challenge, therefore, will be in how to break down the value chain to the client meaningfully.
Mr Janes says this transparency will reassure clients and advisers there has been no undue inducement in that regard by their investment manager to use one firm over another.
They may still end up paying for the research if their firm employs research payment accounts, but it will be clear to them what the cost is and, if the firm pays for research centrally, it could end up in an overall reduction in cost for the client.

> Clients will have a clearer view than ever before of all costs and charges, including the investments

However, there are still some concerns that, while investors will only end up paying for costs relating to their investments, and not to a share of all research bought by a firm, this could limit the choice or breadth of research available.
Only time will tell if the legislation does limit such research, and has a knock\-on negative effect on peoples investments.
**Education**
Overall, the changes being brought in by Mifid II are largely an underscoring of what IFAs already do in the UK. But the additional changes are really a question of education and making sure the providers are giving the right information to advisers and the end client.
Moreover, providers will need to demonstrate to distributors that they fully understand the products and its features, so that advisers and distributors can explain these adequately to the end investor.
With the emphasis on knowing the client, proper product design and appropriate distribution, there should be better documented analysis available to help make the distributors more knowledgeable about the fund universe on which they must advise.
This means advisers will need to be given more information for them to be able to make a more appropriate and suitable recommendation to clients.
_Simoney Kyriakou is content plus editor for FTAdviser_

Mifid II - the next stage of the Markets in Financial Instruments Directive - is just a couple of weeks away from implementation.

This wide-ranging piece of European Union legislation is set to usher in greater transparency around costs and charges, better product suitability and tighter consumer protections when it comes to trading investments listed on exchange.

However, there will be things advisers will have to know from day one, such as how to ascertain how charges disclosure will affect fund recommendations, and to understand how Mifid II will underscore suitability and the advice process.

It will also affect the way in which corporate and retail investors trade instruments such as exchange-traded funds on exchanges, and if any recommendations are made over the phone or online, then advisers must be keeping accurate records of such recommendations.

This report, from FTAdviser and Talking Point, will outline some of the many changes being brought in on 3 January 2017 when the legislation comes into force.

It will give a broad-brush outline of the various elements that affect the retail investment advice process and particular areas to which advisers should pay more attention.

This report qualifies for an indicative 40 minutes' worth of structured CPD.